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There are a few key trends to look for if we want to identify the next multi-bagger. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Having said that, from a first glance at Taylor Devices (NASDAQ:TAYD) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.
Return On Capital Employed (ROCE): What is it?
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Analysts use this formula to calculate it for Taylor Devices:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.033 = US$1.3m ÷ (US$43m - US$2.5m) (Based on the trailing twelve months to November 2020).
Therefore, Taylor Devices has an ROCE of 3.3%. In absolute terms, that's a low return and it also under-performs the Machinery industry average of 9.5%.
While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you're interested in investigating Taylor Devices' past further, check out this free graph of past earnings, revenue and cash flow.
The Trend Of ROCE
In terms of Taylor Devices' historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 17% over the last five years. And considering revenue has dropped while employing more capital, we'd be cautious. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.
On a related note, Taylor Devices has decreased its current liabilities to 5.7% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.
The Key Takeaway
From the above analysis, we find it rather worrisome that returns on capital and sales for Taylor Devices have fallen, meanwhile the business is employing more capital than it was five years ago. Long term shareholders who've owned the stock over the last five years have experienced a 14% depreciation in their investment, so it appears the market might not like these trends either. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.
Taylor Devices does come with some risks though, we found 3 warning signs in our investment analysis, and 1 of those is concerning...
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.
This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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